CAN ONE BAD DECISION LEAD TO FILING BANKRUPTCY?

            Lately, our office has noticed a new trend: Bankruptcy filings for people with only one bad debt. How is this possible? Doesn’t the normal bankruptcy filing result from years of financial problems finally becoming too large to deal with any longer? Not necessarily.

With the financial crisis over the past five years many people significantly reduced their debt burden each month. Cars were paid off and not replaced every 2-3 years, houses were repaired instead of sold and replaced with larger more expensive versions and even credit cards were paid off and kept at a $0.00 balance each month. The overriding issue for people became to keep what they had and not to constantly upgrade and incur new debt.

The financial downturn also lead to a decrease in collection activity. As weird as it sounds, the fact that finances were so dire meant that judgments and collection activity became worthless if there was no ability to pay on the part of the Debtor. Now that the financial markets appear to have recovered somewhat, collection activity is starting to pick up again.

So what about the one mistake that people can make which can lead to bankruptcy? With the accumulation of “paid for” assets such as bank accounts, cars, non-homestead property, equipment or inventory, people and/or companies become vulnerable to a judgment creditor attempting to collect on a new or old judgment. We’ve seen several instances recently of exactly this type of situation, where paying down property has led to the need to file a bankruptcy. Not necessarily to deal with the debt itself, but to protect the paid off property that is subject to a judgment. Even one judgment is usually enough to cause tremendous financial pain to people or companies since the amount of the judgment is more than can be paid off immediately.

Chapter 13 and Chapter 11 bankruptcies offer the opportunity to preserve assets that have been paid off, while offering the ability to work out a partial or complete repayment plan to the judgment creditor. The amount of repayment in any plan is based upon the value of the paid for assets (non-exempt only) and the left over income each month after living expenses have been paid.

CONCLUSION

            Asset protection is a valid reason for seeking bankruptcy protection. Don’t let one mistake ruin years of financial good behavior. Learn how to keep your assets and manage your financial issues by contacting our office.

At Mickler & Mickler, we attend Court on a regular basis. We have the experience and knowledge to ensure that you receive the correct advice when confronted with difficult financial decisions related to filing bankruptcy. Contact us at 904.725.0822 or bkmickler@planlaw.com.

Guarantor Issues in Chapter 11 Cases

            Everything was going so well – you have filed the Chapter 11 case for the corporate debtor and are progressing nicely in the case. Then the main shareholder calls your office in a panic – “I’ve been sued!!!” You immediately start dreaming of huge sanction awards against a malevolent creditor that ignored your corporate Chapter 11. But, alas, the creditor has sued the principal as a guarantor on the corporate debt.

This situation is all too common and can cause substantial harm to the corporate case. Judgments against shareholders can result in garnishment of funds needed to cover corporate shortfalls, result in execution on the corporate stock or cause the shareholder to abandon the corporate case.

If your shareholder cannot or will not consider an individual bankruptcy filing, there are still options available to protect the shareholder (and your corporate case) through the corporate Chapter 11. Our office will, depending on the type of Plan being proposed or the particular situation, file an adversary proceeding in order to extend the provisions of the stay to the non-debtor.

The Chapter 11 Court has the equitable powers under Section 105(a) to enjoin the continuation of collection activities against the non-debtor, which would significantly impact the Debtor’s ability to successfully reorganize. See Carway v. Progressive County Mut. Ins. Co., 183 B.R. 769, 775 (S.D. Tex 1995).

As a general rule, the automatic stay will normally apply to non-debtors only “when a claim against the non-debtor will have an immediate adverse economic consequence for the debtor’s estate.” Queenie, Ltd. v. Nygaard, Int., 321 F.3d 282, 287 (2d.Cir.2003). As cited by the Queenie Court, examples are a claim to establish an obligation of which the debtor is a guarantor, McCartney v. Integra National Bank North, 106 F.3d 506, 510-11 (3d Cir. 1997), a claim against the debtor’s insurer,   Johns-Manville Corp. v. Asbestos Litigation Group (In re Johns-Manville Corp.), 26 B.R. 420, 435-36 (Bankr. S.D.N.Y. 1983) (on rehearing), and actions where “there is such identity between the debtor and the third-party defendant that the debtor may be said to be the real party defendant . . .,” A.H. Robins Co. v. Piccinin, 788 F.2d 994, 999 (4th Cir. 1986). Capital contributions from the shareholder are also a good reason to extend the provisions of the stay to the non-debtor. The fact that the co-debtor’s capital contributions are available to fund Debtor’s Plan warrants extension of the stay to the necessary co-debtor. See In re Hamlin’s Landing Joint Venture, 81 B.R. 651, 653 (Bankr. M.D. Fla. 1987).

If you are considering Chapter 11 for a corporation and have a personal guarantee issue, consider the above when deciding on which attorney’s office to utilize. Ask how the attorney will handle a situation where a personal guarantee action has been filed. Our office has the experience to recommend the appropriate course of action in such a situation, whether it requires filing a separate bankruptcy petition or attempting to stay the suit through an extension of the automatic stay.

Contact our office at 904.725.0822 or bkmickler@planlaw.com for a free consultation regarding filing bankruptcy.

The absolute-priority rule was a judicial invention intended to prevent equityholders and secured creditors from colluding to the detriment of unsecured creditors.[1] The Bankruptcy Reform Act of 1978 codified the absolute-priority rule at 11 U.S.C. § 1129(b)(2)(B)(ii), which requires for dissenting unsecured creditors to be paid in full before equityholders may retain property under a reorganization plan.

The absolute-priority rule is “generally applied to for-profit corporations facing bankruptcy, where an equityowner seeks to retain property, often represented by stock.”[2] The applicability of the absolute-priority rule to a nonprofit debtor presents an uncommon question. The only two circuit courts of Appeal to decide the issue have found the absolute-priority rule does not apply to nonprofit debtors.

Seventh Circuit: Absolute-Priority Rule Does Not Apply to a Nonprofit Electric Utility     The Seventh Circuit analyzed the absolute-priority rule in the context of an electric utility cooperative.[3] The Seventh Circuit ruled that members (equityholders) of a nonprofit debtor did not hold “interests” in the debtor and therefore the debtor’s reorganization plan did not violate the absolute-priority rule. The dissenting unsecured creditor in Wabash objected on the grounds that the member cooperatives retained control of the reorganized debtor and received some economic benefit from the reorganized debtor. The Seventh Circuit found the “member cooperatives…do not improperly retain property ‘on account of’ either their patronage capital accounts (which are mere refunds of overpayments) or their control over [the Debtor].”[4] Identifying three indicia of ownership (control, profit share and ownership of corporate assets), the Wabash court determined that retention of managerial control was insufficient to trigger the absolute-priority rule in the context of an electric utility.

In concluding that the member cooperatives did not retain an interest in the reorganized debtor, the Seventh Circuit relied on Indiana state law as it pertains to nonprofits in general as well as regulation on Indiana utility companies. Generally, Indiana law prohibits nonprofit companies from paying dividends to its members and provides that, upon dissolution, any equity in assets escheats to the state.[5] As to utility regulations, the Seventh Circuit found it important that Indiana law prohibited the debtor from charging customers more than the cost of electricity provided.[6]

Thus, the Seventh Circuit’s decision is limited to some extent as the debtor was an electric utility. However, the decision still may generally apply to any nonprofit chapter 11 debtor. Provisions similar to the Indiana statutes noted in Wabash may exist in the law of one’s jurisdiction. For example, under Florida law, nonprofit corporations are prohibited from making distributions to its members, subject to limited exceptions.[7]

Ninth Circuit Expands on the Wabash Decision     Ninth Circuit relied on Wabash in ruling that an international labor union was not an owner of its local branches for purposes of the absolute-priority rule.[8] In the Teamsters case and unlike the circumstances in Wabash, the debtor held a contingent future interest in the assets of any dissolved local union. The Ninth Circuit found this insufficient to establish ownership without any other indicia of ownership. The Ninth Circuit noted the rationale behind the absolute-priority rule as it pertains to for-profit chapter 11 debtors. The concern of an equityholder is purely an economic one, focused on the profitability of the corporation.

Other courts have applied slightly different rationale in reaching the same conclusion as the Seventh and Ninth Circuits.Rather than focusing on the interest retained by equityholders, the court in In re Save Our Springs Alliance Inc.[9] found that a nonprofit corporation simply has no equityholders. The debtor in that case existed to promote water conservation in west Texas. The court did not find it necessary to examine the indicia of ownership or other factors, but cited the circuit court decisions that the proposition that the equityholders did not retain an interest in the reorganized debtor.

Conclusion     The applicability of these decisions to other types of nonprofit organization will largely hinge on the stated purpose of a given debtor and the existence of monetary incentives for the equity holders provided in a proposed plan of reorganization. As explained by the Ninth Circuit, the absolute-priority rule exists to prevent abuse by debtors with solely pecuniary motivation, which is the motivation of most business ventures. The same rationale behind the absolute-priority rule fails where the debtor exists to serve a community function, such as in the context of a labor union, electric cooperative, historical society, environmental protection group or religious organization.

1. See In re Wabash Valley Power Ass’n, 72 F.3d 1305, 1314 (7th Cir. 1996).